Author: Wind Trading Station

Google's parent company Alphabet has reported an impressive second-quarter performance, with cloud business growth far exceeding expectations, and overall revenue and earnings per share significantly beating Wall Street forecasts. However, the stock price still plummeted, reflecting market concerns over sharply increased capital expenditures, negative free cash flow, and equity dilution among other deeper issues.

According to a report by Bank of America Securities, Alphabet's net revenue for the second quarter reached $103.6 billion, surpassing the market expectation of $101.1 billion, with Google Cloud revenue growing 82% year-over-year, far exceeding the market's expectation of 65%, demonstrating particularly strong momentum.

At the same time, the company raised its capital expenditure guidance for the fiscal year 2026 by $15 billion to a range of $195 billion to $205 billion, a significant increase from the previous guidance of $180 billion to $190 billion, making this news a core variable suppressing the stock price.

Bank of America Securities analyst Justin Post maintained a "Buy" rating on Alphabet in the report, with a target price of $430. He noted that despite the negative market reaction to the increased capital expenditure, the backlog of cloud business orders, customer overspending, and the continuous expansion of cloud profit margins all indicate that incremental investments are directly translating into revenue growth.

In pre-market trading, Google’s stock decline widened to nearly 5%.

Explosive Growth in Cloud Business Becomes the Season's Highlight

Google's cloud business achieved remarkable accelerated growth this quarter.

Cloud revenue for the second quarter reached $24.8 billion, an 82% year-over-year increase, not only significantly surpassing the market expectation of 65% but also showing an increase of 19 percentage points from the first quarter's 63%. The cloud business operating profit margin rose to 35.6%, also exceeding the market expectation of 31.3%, an increase of 270 basis points from the previous quarter, and up nearly 15 percentage points year-over-year.

Bank of America Securities' report pointed out that the strong performance of the cloud business is supported by several data indicating its sustainability: the cloud business backlog grew by 11% quarter-over-quarter and approximately 375% year-over-year, reaching $514 billion; customer actual consumption exceeded contract commitments by over 50%, up from 45% in the first quarter; and the pace of acquiring new customers is more than double that of the same period last year.

Additionally, this quarter included new revenue from selling TPU chips to external customers, with management stating that even excluding TPU sales, cloud business growth would still "significantly accelerate."

Google's model API currently processes about 22 billion tokens per minute, a significant increase from the previous quarter's 16 billion; the weekly active users of the AI agent development platform AntiGravity have exceeded 2.4 million. Bank of America Securities predicts that in the third quarter, Google Cloud revenue growth will further accelerate to 93%.

Search and Overall Performance: Exceeding Expectations but Uneven Highlights

Overall, Alphabet’s GAAP earnings per share for the second quarter were $9.11, significantly surpassing the market expectation of $2.90, but it is important to note that this includes approximately $98 billion in other income, primarily from the reassessment gain from Anthropic, while the market previously expected this to be only $800 million. Excluding this one-off factor, the core business performance is more authentic.

Search business revenue was $63.3 billion, a 17% year-over-year increase, which is basically in line with market expectations but somewhat weaker compared to the over-expected performance in the previous quarter, leading the market to view it as a sign of recent AI uptrend logic’s temporary "cooling."

Management also indicated that the search business would face higher year-over-year baseline pressure in the third quarter.

YouTube ad revenue was $11.1 billion, a 13% year-over-year increase, exceeding the market expectation of $10.8 billion, partly benefiting from brand advertising demand linked to the FIFA World Cup. In terms of operating profit margin, the GAAP operating profit margin for the second quarter was 39.3%, below the market expectation of 40.3%, mainly dragged down by overspending on G&A expenses—actual G&A expenditure was $6.46 billion, far exceeding the market expectation of $5.1 billion, with management attributing this to several legal and other matters, without providing further details.

Soaring Capital Expenditures and Negative Free Cash Flow: The Market's Greatest Concern

The market's negative reaction to this quarter's performance primarily revolves around the significant increase in capital expenditures and its impact on cash flow.

Alphabet raised its capital expenditure guidance for fiscal year 2026 to a range of $195 billion to $205 billion, an increase of about 8% over the previous guidance and significantly higher than the market expectation of $187 billion. Bank of America Securities predicts a negative free cash flow of $16 billion for the entire year of 2026, with a similar negative forecast for 2027.

Meanwhile, Alphabet did not repurchase any stock in the second quarter, resulting in a negative free cash flow of $5.9 billion. Following the completion of a $45 billion mixed capital financing in June this year, the company plans to initiate a $40 billion at-the-market (ATM) equity issuance plan in the third quarter, which Bank of America Securities expects will lead to a quarterly increase in diluted shares of about 1% in the second half of the year.

Bank of America Securities analyst Justin Post noted that despite these factors posing short-term pressure, the increase in capital expenditure is directly linked to the rapid growth of cloud business backlog— the $514 billion backlog significantly exceeds the $15 billion increase in capital expenditures, meaning that "more capacity equals more sales" logic still holds. He maintains a forecast of approximately $200 billion in capital expenditures for 2026, and raised the 2027 capital expenditure forecast to about $300 billion, an increase of approximately 51% year-over-year.

Valuation and Rating: Current Price Remains Attractive

Bank of America Securities maintains a "Buy" rating on Alphabet with a target price of $430, based on a projected adjusted GAAP earnings per share for 2027 of $15.55 multiplied by a 27x price-to-earnings ratio, plus $11 per share in cash.

The report raises the 2026 net revenue forecast by 2% to $433.6 billion, with earnings per share increased by 4% to $20.58; the 2027 net revenue forecast is increased by 3% to $552.8 billion, and earnings per share is raised by 2% to $15.01.

At an after-hours price level of approximately $332, Alphabet has a price-to-earnings ratio of about 22x corresponding to 2027 GAAP earnings per share, which is on par with the company's 10-year historical average, but Bank of America Securities expects the revenue growth rate for 2027 to reach 27%, far above the average level of 14% from 2023 to 2025.

From a segment valuation perspective, after excluding YouTube, cloud business, Waymo, and cash and other assets, the implicit valuation of Google's core advertising and Play business is only 13 times the expected earnings for 2026, below the 20 times of the S&P 500 index.

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